Contra Account Definition

A regular asset account typically carries a debit balance, so a contra asset account carries a credit balance. Two common contra asset accounts include allowance for doubtful accounts and accumulated depreciation. Allowance for doubtful accounts represents the percentage of accounts receivable a company believes it cannot collect.

Accumulated depreciation has a natural credit balance but it is still an asset. I won’t go into details about accumulated deprecation also having the ability to be debited, but it can never have a debit balance. Accumulated depreciation is just the most well known contra account. Debits bookkeeping examples and credits are traditionally distinguished by writing the transfer amounts in separate columns of an account book. Alternately, they can be listed in one column, indicating debits with the suffix “Dr” or writing them plain, and indicating credits with the suffix “Cr” or a minus sign.

Indian merchants had developed a double-entry bookkeeping system, called bahi-khata, predating Pacioli’s work by at least many centuries, and which was likely a direct precursor of the European adaptation. Prior to January 2, ABC has a commitment but will not have a liability. Unearned Revenue should be credited because ABC has not earned the $1,000 and ABC has an obligation to perform the service in the future. the books, and electronic deposits on the bank statement that are not yet recorded on the books. Designed for freelancers and small business owners, Debitoor invoicing software makes it quick and easy to issue professional invoices and manage your business finances.

Despite the use of a minus sign, debits and credits do not correspond directly to positive and negative numbers. When the total of debits in an account exceeds the total of credits, the account is said to have a net debit balance equal to the difference; when the opposite is true, it has a net credit balance. For a particular account, one of these will be the normal balance type and will be reported as a positive number, while a negative balance will indicate an abnormal situation, as when a bank account is overdrawn. Debit balances are normal for asset and expense accounts, and credit balances are normal for liability, equity and revenue accounts. It is located in the long-term asset section of the balance sheet under the heading of property, plant, and equipment. The book value of an asset is the value of the asset recorded in the company’s balance sheet. Contra accounts are needed for determining the book value of assets held by a company.

Why Are Contra Asset Accounts Important For Businesses?

These billings may usually be documented on invoices, which are then summarized in an aging report for all the business’s accounts receivable. Depreciation is the method of accounting used to allocate the cost of a fixed asset over its useful life and is used to account for declines in value. It helps companies avoid major losses in the year it purchases the fixed assets by spreading the cost over several years. Your allowance for doubtful accounts estimation for the two aging periods would be $550 ($300 + $250). Use the accrual accounting method if you extend credit to customers.

The net realizable value of the accounts receivable is the accounts receivable minus the allowance for doubtful accounts. Contra accounts are reported on the same financial statement as the associated account. For example, a contra account to accounts receivable is a contra asset account. This type of account could be called the allowance for doubtful accounts or bad debt reserve. The balance in the allowance for doubtful accounts represents the dollar amount of the current accounts receivable balance that is expected to be uncollectible.

• When reporting these corresponding accounts in the company’s balance sheet, the net amount will be $22,500 while the $2,500 in the contra account would be reported in the income statement as bad debt expenses.
• If company A has $25,000 in its accounts receivable and estimates that 10% would be uncollected.
• For accounting purposes, the book value is realized by the difference between the asset’s account balance and contra account balance.
• Each contra asset account serves a different specific purpose, but they are have a couple things in common, too.
• Contra accounts play a major role in estimating the book value of an asset.
• Contra accounts are needed for determining the book value of assets held by a company.

Creating this contra asset account builds in a safeguard against overstating your accounts receivable balance. Contra adjusting entries asset accounts will always carry a credit balance since the accounts they are associated with have a debit balance.

Types Of Contra Asset Accounts

For example, your ADA could show you how effectively your company is managing credit it extends to customers. When customers don’t pay you, your bad debts expenses account increases.

The Profit and Loss Statement is an expansion of the Retained Earnings Account. It breaks-out all the Income and expense accounts that were summarized in Retained Earnings. The Profit and Loss report is important in that it shows the detail of sales, cost of sales, expenses and ultimately the profit of the company. Most companies rely heavily on the profit and loss report and review it regularly to enable strategic decision making. The book value of a corporation is the total amount of stockholders’ equity reported on the balance sheet. The total amount reported for stockholders’ equity is the approximate fair value or net worth of the corporation as of the balance sheet date.

In most scenarios, we credit the accumulated depreciation account because, as time passes, the company records the depreciation expense that is accumulated in the contra-asset account. However, there are situations when the accumulated depreciation account is debited or decreased. For example, let’s say an asset has been used for 5 years and has an accumulated depreciation of $100,000 in total. After the 5-year period, if the company were to sell the asset, the account would need to be zeroed out because the asset is not relevant adjusting entries to the company anymore. Therefore, there would be a credit to the asset account, a debit to the accumulated depreciation account, and a gain or loss depending on the fair value of the asset and the amount received. Accumulated depreciation is an asset account with a credit balance known as a long-term contra asset account that is reported on the balance sheet under the heading Property, Plant and Equipment. The amount of a long-term asset’s cost that has been allocated, since the time that the asset was acquired.

A bad debt is debt that you have officially written off as uncollectible. Basically, your bad debt is the money you thought you would receive but didn’t. Accumulated Depreciation is usually a long-term asset that you keep on your balance sheet retained earnings to show the net effect of your asset and what has been depreciated. Examples include trust accounts, debenture, mortgage loans and more. The third line of the balance sheet at the end of the year should begin with “For the Year Ended”.

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If company A has $25,000 in its accounts receivable and estimates that 10% would be uncollected. When reporting these corresponding accounts in the company’s balance sheet, the net amount will be $22,500 while the $2,500 in the contra account would be reported in the income statement as bad debt expenses.

An adjunct account is an account in financial reporting that increases the book value of a liability account. Contra accounts are presented on the same financial statement as the associated account, typically appearing directly below it with a third line for the net amount. A contra account is an account used in a general ledger to reduce the value of a related account. At the end of the first year, net value of the equipment would be $300,000 – $50,000 in accumulated depreciation, so the net value of the equipment at the end of the first year would amount to $250,000. Financial modeling is performed in Excel to forecast a company’s financial performance. Current assets are not depreciated because of their short-term life.

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Allowance for doubtful accounts offsets a company’s accounts receivable account. Accumulated depreciation offsets a company’s real property assets, such as buildings, equipment and machinery. Accumulated deprecation represents the cumulative amount of depreciation expense charged against an asset. Some balance sheet items have corresponding contra accounts, with negative balances, that offset them. Examples are accumulated depreciation against equipment, and allowance for bad debts against accounts receivable. United States GAAP utilizes the term contra for specific accounts only and doesn’t recognize the second half of a transaction as a contra, thus the term is restricted to accounts that are related.

Contra Asset Account

Accumulated amortization and accumulated depletion work in the same way as accumulated depreciation; they are all contra-asset accounts. The naming convention is just different depending on the nature of the asset.

Contra asset accounts are a type of asset account where the account balance may either be a negative or zero balance. This type of account can equalize balances in the asset account that it is paired with on a business’s balance sheet. The contra asset account has credited balances that can reduce the balance in its paired asset account. A company can choose to state this information as separate line items on its balance sheet so that any financial planners or analysts can determine the extent to which a paired asset might be reduced.

An Example Of Recording A Contra Asset

It is a contra-asset account – a negative asset account that offsets the balance in the asset account it is normally associated with. Accumulated depreciation is not an asset because balances stored in the account are not something that will produce economic value to the business over multiple reporting periods. Accumulated depreciation actually represents the amount of economic value that has been consumed in the past. It appears on the balance sheet as a reduction from the gross amount of fixed assets reported. As you can tell, there are a few moving parts when it comes to allowance for doubtful accounts journal entries.

When a company evaluates its financial position, a financial analyst might calculate the total amounts that the company stores in its asset accounts. While financial information on these accounts might include receivables collected, the company can also choose to include its contra asset accounts as a separate line item on the balance sheet. At the end of the quarter/term you would close out these contra asset accounts by canceling business bookkeeping them out with their corresponding “asset” by Zero-ing out the Contra Asset account into the corresponding Asset account. Not sure if this is all correct, I’m a student as well but I’m a little rusty. So, essentially, all these situations are mistakes that people could make. The only real reason you would want to have asset accounts with a credit balance is if they were intentionally set up as a contra asset account.

An accumulated depreciation account is a type of contra asset account that is used for recording the amount of depreciation a fixed asset evolves through. For instance, a fixed asset such as machinery, a company building, office equipment, vehicles or even office furniture would be highlighted in an accumulated depreciation account. This amount may appear on a company’s balance sheet, and it can ultimately result in a reduction in the gross amount of a business’s fixed assets. This type of asset account is referred to as “contra” because normal asset accounts might include a debit, or positive, balance, and contra asset accounts can include a credit, or negative, balance.